The hallmark of a good investor realizes that the rules do apply to them and they own the fact that they are no more gifted or special than the next person. Most investors tend to leave about 50% of their profits on the table due to bad emotional decisions

Say what you will about hedge fund managers, but, at the end of the day their net worths and livelihoods depend almost entirely on their investments in their own funds. The same is true of private equity titans and the CEOs of most public companies.

Outflows from the SPDR Gold Shares exchange-traded fund (GLD) — far and away the largest exchange-traded commodity fund by assets — have totaled nearly $1.4 billion over the five sessions ending Friday

Investors Flee Gold Fund at Fastest Pace in Over Three Years After Trump Win – (Bloomberg)

Oil futures rallied Thursday in the wake of OPEC’s production-cut deal, with West Texas Intermediate crude topping $50 a barrel to end at a six-week high and Brent crude logging its best finish since August 2015.

Industrial metals rallied almost 30 percent in 2016 as demand stabilized in China, U.S. President-elect Donald Trump pledged to invest in infrastructure and revitalize the U.S. economy, while mine closures curbed supply.

“If the government did acquire one of these companies or even became an investor in one of these companies, that investment could be called back to the holding company and whoever that investor or company was, would be kicked out of the group,” he said.

Just for Fun:

The holidays will be much happier for families of 1,500 workers at Exelon Corp.’s Clinton and Quad-Cities nuclear power plants after the Illinois General Assembly voted Thursday to approve an energy policy overhaul that will keep the plants open for another decade.

With its proximity to the Arctic, Alaska is warming about twice as fast as the rest of the United States and the state is heading for the warmest year on record. The government has identified at least 31 Alaskan towns and cities at imminent risk of destruction, with Shaktoolik ranking among the top four.

A Wrenching Choice for Alaska Towns in the Path of Climate Change – (New York Times)

It’s a similar story in Alaska, which had the nation’s third-highest per capita tax revenue in 2014 (Vermont was No. 2). Severance taxes account for a whopping 72 percent of Alaska’s tax revenues.

But as we looked into the deal, and others like it, we began to realize how little we knew about the U.S. government’s assistance budget, which ranges from programs combating HIV/AIDS to those directly funding other nations’ armed forces.

Everything you ever wanted to know about the U.S. foreign assistance budget – (Washington Post)

The Netherlands and Belgium, with their royals in attendance, on Monday signed a deal for a peaceful exchange of land between them for the mere fact that it makes sense to do so.

The size of a large caribou herd in Alaska’s Arctic region has dropped by more 50 percent over the last three years, and researchers who have tentatively ruled out hunting and predation as significant factors for the decline are trying to determine why.

What is a flower like from a bee’s perspective, and what does the pollinator experience as it gathers pollen? And that’s why we’re talking to you in the second person: to help you understand how bees like you, while hunting for pollen, use all of your senses — taste, touch, smell and more — to decide what to pick up and bring home.

As if we weren’t already sick of hearing about voting – 2016 is continuing its run as the Year of the Vote – with yet another important vote around the corner in what some are calling a lighter version of the Brexit and Trump shockers. You’re up Italy, with a vote on amending their constitution to change the number of members in the senate as well is stripping them of some of their power. Here’s the simple explanation via Bloomberg, and more involved one from the Wall Street Journal.

The basic pitch is that there are too many overpaid senators that need to be got rid of to enable laws to be passed quickly and efficiently. Bberg

They are voting on a reform that would overhaul Italy’s legislature, mainly by stripping the Senate of most of its powers and replacing its 315 directly elected members with 100 local officials. The Senate would also lose its power to hold votes of confidence on new governments, leaving that responsibility entirely to the lower house. – WSJ

If a yes were to pass, Italians would no longer elect their senators, and they would thus forth be appointed by mayors or governors. Can you imagine if Americans had voted a couple weeks ago to change the number of members in the senate from 100 to 50 and you no longer were able to vote for them? It’s this big.

What Would a “No” vote mean?

As if we all haven’t learned enough from Former U.K. Prime Minister David Cameron’s ultimatum to step down if Brexit happened, the current Prime Minister Matteo Renzi followed his lead, saying he would resign if the Italy votes “no” on the referendum, which would keep things the way they are now.

Worst case scenario for people who are pro-EU? A No vote could fuel the fire of the Five Star Movement Party, who’s lead is an advocate of leaving the E.U. But The Economist says… not so fast.

The ingredients for a crisis are there. But qualifications are needed. Mr Renzi’s departure would not necessarily lead to a general election. It would be up to president Sergio Mattarella to consult party leaders to see who they would back as a replacement. They might even agree to Mr Renzi’s return. Nor would an eventual general election necessarily put the M5S in office. Its newly-elected mayor of Rome has struggled to cope and the movement now faces a scandal: three of its lawmakers are under investigation in Sicily, suspected of electoral fraud. If the mainstream parties can agree on a caretaker administration, moreover, its main task will be to change the electoral law (which currently applies to only one of the two legislative chambers). The traditional parties are highly likely to seize the opportunity to stack the odds against the M5S.

Italy’s Banking Problem

To understand why Mr. Renzi would make such a bold ultimatum comes back to the economy and economic reform. Italy is still dealing with the after-effects of the 2008-2009 financial crisis, and the banks still have loans to prove it, to the tune of €360bn of impaired loans.

Among the hardest hit is the world’s oldest bank, Monte dei Paschi di Siena (MPS). It is currently trying to bolster its accounts with a €5bn recapitalisation, the success of which is far from assured. Italy’s public debt stands at more than 132% of GDP, so a banking crisis would doubtless boost the country’s borrowing costs.

A no votes creates a domino effect. The speculation is that if no wins, the Italian banking system will not get the reform it needs because the Italian parliament system is too crowded. Inaction could cause economic doom for Italy, because of the EU’s rule about bailing out banks.

New EU rules forbid governments bailing out banks. Instead, they demand that shareholders and bondholders, be ‘bailed in’, forcing them to accept heavy losses that would otherwise be foisted on taxpayers. In Italy, however, bank debt worth around €170bn is in private hands and it is unclear whether any government in Rome could stand by while voters lost their savings.

I skipped to the bottom, how does this affect markets?

The Euro is at 13-year lows not seen since 2003 – after falling 10 straight days. Many are speculating that a no vote could get the ball rolling on Italy creating economic turmoil while at the same time fueling the fire to leave the E.U. Another country leaving the E.U. could mean an even larger drop in the currency, leaving the door open for other countries considering it such as Austria, the Netherlands, and France.

(Disclaimer: Past performance is not necessarily indicative of future results)

The worry for traders is yet another binary type event like Brexit or the Swiss Franc Depegging from the Euro. This likely isn’t as big of an event, but it’s next on traders radars nonetheless – where surely some (or their computer algorithms) will try and make it as big of an event as they can to push markets one way or another.

We’ve been waiting… and waiting… and waiting… for the markets. to. finally. move. With the election over, we’re now seeing it unravel. The U.S. Dollar Index is at levels not seen since 2003, Copper has roared up 20% in a week, and Gold is getting crushed. And that short list doesn’t include the biggest “market” – the U.S. stock market’s push to new all-time highs.

It’s time like these where logging into your investment account is a great idea if you’re a firm believer of the “buy, hold, and forget” club. What’s not to like? We all know about the market being up big since the 2009 lows, but now the market is up roughly 50% from its 2007 peak and looks as though it’s showing signs of breaking out of a 16-year range. It’s rainbows and lollipops all around…

…except in the world of Alternatives. Sure – there’s been an explosion of assets into alternatives since the 2008-2009 financial crisis. Sure, they are developing ever new and innovative ways of finding alpha or offering cheap alternative beta in the markets. But for all the effort, nobody seems to be able to keep up with the mighty US stock market. It seems easier to just buy a low-cost index fund.

Which got us to thinking. How much do stocks need to outperform alternatives in order for the long term benefit of alternatives to be made insignificant? In short, when is the excess return worth the increased risk? For all of those who decry hedge funds for underperforming stocks over the past few years – the answer is not very much. They seem to think a year or two of stocks outperforming stocks + alternatives means there’s no need for the diversification. Raise your hand if you’ve read an article about the massive shift into passive investments recently, or such and such pension fund dropping hedge funds because they aren’t seeing the value.

So what’s going on? Are alternatives no longer needed, or are lots of people suffering from a massive dose of recency bias? We decided to put the numbers to the theory, comparing a Diversified portfolio (36% stocks, 24% bonds, 40% Managed Futures) against a simple 60/40 portfolio going back to 2011, 2006, and the start of the millennium – 2000.

Given the headlines, it should be no surprise that the past five years show the basic 60/40 portfolio out performing a portfolio with alternatives. It would be hard to argue against complex alternatives investments and the wisdom of just sticking with simple passive indexing without such a graph.

The portfolio with alternatives underperformed a traditional portfolio just about the entire time, reminding us of an old line from the hoops classic Hoosiers: “Sun don’t shine on the same dog’s ass every day, but, mister you ain’t seen a ray of light since you got here.” Here are the stats for those into the nitty gritty.

So why has there been such growth and interest in Alternatives? Look no further than the comparison between a traditional portfolio and one containing alternatives over the past 10 years, going back through the financial crisis. Now, these two “lines” have ended up at essentially the same place over 10 long years, but just like you and that hippy cousin at Thanksgiving, the paths that were taken to get there were quite different.

(Disclaimer: Past performance is not necessarily indicative of future results)

While the “lines” might not do the difference between these two paths all that much justice, we can really see the benefits of an alternatives allocation in the statistics – with the max drawdown roughly cut in half, and the volatility about 2/3 that of the 60/40 portfolio. But this just begs the question: is a savings of 16% on the downside over the long term, worth an underperformance of 16% over the short term (past 5 yrs).

We might rush to say this is a wash, with the 16% savings offsetting the 16% loss, and the 10-year chart sort of bears this out with both strategies finishing around the same place. But it’s a bit more nuanced than that. Ask yourself whether you panicked during the 2008 crisis. Ask yourself how much more likely you’d be to throw in the towel when your portfolio is down -30% versus -15%. It’s easy to say you’re sticking with passive investing while we’re here at all time highs -it’s quite another when you’ve lost a third of your investment account and staring at world markets falling 50% or more during a crisis. What the stats don’t show is the diversified portfolio’s ability to keep you in the game… to keep you from getting out at the wrong time.

Which brings us to the very long term, looking back to the start of the SocGen CTA index in 2000.

(Disclaimer: Past performance is not necessarily indicative of future results)

And this – my friends – is why alternatives are worth it. Unless you’re getting started when you’re 85, investing isn’t a 5-year test. It’s hardly even a 10-year test. We’re talking 25, 50, and even 75 years of assets at work in the “markets” for some people, where the benefits of compounding and diversification show up more and more the longer you’re allowing them to work.

And what benefits they are, with the return higher, the volatility lower, and max drawdown still roughly half of what it is in a non-diversified portfolio. Past performance is not necessarily indicative of future results, and that’s the whole point. Alternatives may look nothing like their return stream since 2000, but neither may stocks. The non-correlation and mixture of the two are what makes it work over the long term.

In the meantime, we’ll always have periods of underperformance and over performance and everything in between as assets cycle into and out of beneficial market environments, leading to broad proclamations that hedge funds are dead, stock markets are broken, and so forth and so on. But those with a longer view see something different. They see non-correlation in action – with different return drivers producing different looking return streams over short periods of time. They see better risk adjust performance over the long term even when employing a strategy that is underperforming in the short term.

Are the markets really reacting to the FBI’s news that they’re looking at more emails tied to former Secretary of State Hillary Clinton? Whatever you might think is moving the markets, it seems that it’s not just equities that are slumping.

Every asset class we track albeit cash, took a dive in the month of October. Whether it’s the combination of jigsaw energy markets, a potential “hard Brexit” pushing currencies lower, or everyone sitting on needles waiting for the fed to make another decision about raising interest rates, there was enough volatility to push markets lower on the month.

It’s eerie how close Stocks, Bonds, and the Real Estate markets are in their YTD numbers. Meanwhile, Managed Futures entered negative territory for the second time in 2016 as managers were unable to capture markets that seem to be stuck in a range {Past performance is not necessarily indicative of future results}.

Earlier this week, we gave a brief recap of CBOE Director of Education’s Russell Rhoads presentation of VIX Futures, but that was just half the fun. We also had four professional hedge fund managers (technically, commodity trading advisors since these are VIX futures) share how they view volatility as an investment opportunity, not just a fear gauge. They aren’t just any hedge fund managers, these are four of the first professional traders to offer volatility focused investment programs to investors on a standalone basis using VIX futures and VIX options.

Here’s what you should know about VIX Futures and the people and systems that trade them professionally.

Is VIX a hedge or an alpha generator?

While most see the utility of VIX Futures as a means to hedge a portfolio – many of our panelists don’t view it as a hedge whatsoever. Mike Thompson of Typhon and Tim Jacobson both agreed that they see it mainly as an alpha generating tool, depending greatly on the market environment (ie. it’s not as simple as just buying or selling the VIX, a more sophisticated strategy needs to be used). Lawrence McMillan sees it as a bit of both; using VIX options as the alpha generator, VIX futures as a hedge on that alpha, noting that the public likely views it as “insurance” in your portfolio.

Brett Nelson, of Certeza stood the question on its head, asking the audience to think of the S&P 500 as a hedge of the VIX, not vice versa.

Are the infamous VIX spikes cause for alarm, or joy, for your program?

The general consensus of spikes in the VIX was that they can be scary in the moment, depending on the positioning of the portfolio coming into such a spike (remember these guys are equally as comfortable betting on increases as decreases in the VIX). Tim Jacobson went on to say they welcome these spikes as they can provide opportunity but that we all must “respect them.”

But each panelist mentioned that the spikes often be joy-inducing shortly followed by – as the spikes typically represent over buying and over protection by other market participants. That overbuying can cause market inefficiencies which is exactly what their programs look to extract.

There was also discussion around when and how the spike happens – with panelists commenting that a spike on top of already elevated volatility is quite different than a spike from historically low volatility levels (with the latter being a bit more dangerous). Thompson also made an interesting point here that recent spikes have seen shorter and shorter ‘half lives’, so to speak, with the VIX more quickly reverting to the mean after recent spikes than seen in years past.

How do these models work?

There’s not enough room for the dissertation it would take to really get into these models and how they work, but each tends to approach the VIX from a market structure standpoint – trying to capitalize on its unique tendencies being a qaudrivative of sorts, where arbitrage opportunities can exist when one of the legs of that derivative of an index of a derivative of an index doesn’t keep pace with the other legs.

Brett Nelson of Certeza describes his approach as “stat arb”, or more officially – statistical arbitrage – which in this case manifests itself on the VIX as volatility arbitrage. In simplistic terms, the program will calculate where it believes various contract months of VIX futures should be priced at, and upon finding a mispricing, either buy or sell to take advantage of that pricing potentially reverting to where it should statistically be given the inputs.

Tim Jacobson of Pearl Capital uses the market structure in a slightly different way, using the VIX futures to monetize the differential between the volatility implied by the VIX and the volatility actually produced by the S&P 500. The Pearl strategy, therefore, can play the VIX futures when they are rising or falling and independent of overall market direction.

Mike Thompson of Typhon is a relative value program focused on the shape of the VIX futures curve. He looks for price inefficiencies in VIX futures by going long front month / short back month or short front month / long back month depending if VIX futures is in contango or backwardation.

Finally, Lawrence McMillan essentially “sells” volatility, utilizing VIX options, not VIX Futures, and attempting to capture the premium decay therein. Unlike the other three managers, Lawrence sees the VIX futures as a way to hedge his short option profile from big spikes in volatility.

Where is volatility and the VIX going from here?

We couldn’t let these pros out of the room without asking what they see in the current volatility environment and it could be going into 2017. While many systematic managers complain about the central bank intervention messing with normal market movement, the panel seemed resigned and comfortable with this current regime until it changes.

Of course, they all felt we’re currently in a very low volatility environment, which some pointed out makes what they do a little more difficult (as the deltas on any increases in volatility can be greater than they otherwise might be coming from such depressed levels). From there, there were answers as varied as ‘I Don’t care what environment we’re in – it doesn’t matter to our dynamic model’, to comments that Ray Dalio’s Bridgewater is looking at Japan as a proxy for what might happen in US markets following massive stimulus.

The crowd asked whether this unpredictable presidential campaign would lead to a very unpredictable (and therefore market volatile) election day/week/month; to which the panel generally answered, no. The reason is because that information is already known who the candidates are and that one of them is a little unorthodox. Essentially, it’s already “priced in” to the market.

Tim Jacobson had a great talking point here, saying to think of the VIX as a radar screen – where all of the known information the market is reflected on the screen in various blips and dots. The sum of all that information comes out to be the current VIX level. Continuing, he stated that unless one of those known blips becomes larger, or a new unforeseen blip hits the screen, the VIX won’t move. The larger the blip and more unexpected its arrival on your screen (and closeness to your ship) the larger the movement in the VIX will be.

Should ‘Volatilty’ be an asset allocation?

This may have been a better question for a panel of asset allocators, but the answers were interesting nonetheless. After the standard disclaimers by the panel that they don’t know the specifics of each investor’s portfolio and thus not giving specific advice on specific portfolios – we got answers centering around a baseline of ‘yes, this should definitely be part of a balanced portfolio; Along with comments that it’s not just a good diversifier to a traditional portfolio, but also a great add to an alternatives portfolio which typically relies on momentum based, volatility expansion seeking strategies. Tim Jacobson had the interesting perspective that they work at a family office and designed the program just for this reason, to provide exposure in the portfolio to volatility as an asset class; while Brett Nelson considers 30-40% an appropriate allocation.

We’ll add our own commentary here, that it is a very attractive space from our viewpoint, being generally a low margin usage product with low correlations to the rest of the managed futures space. This allows investors to add it to current portfolios of managers with very little impact in terms of additional capital or additional portfolio level drawdowns and added volatility.

P.S. – If you want the full presentation from the event, email us at invest@rcmam.com

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DISCLAIMER

Forex trading, commodity trading, managed futures, and other alternative investments are complex and carry a risk of substantial losses. As such, they are not suitable for all investors. You should not rely on any of the information as a substitute for the exercise of your own skill and judgment in making such a decision on the appropriateness of such investments.

The entries on this blog are intended to further subscribers understanding, education, and - at times - enjoyment of the world of alternative investments through managed futures, trading systems, and managed forex. Unless distinctly noted otherwise, the data and graphs included herein are intended to be mere examples and exhibits of the topic discussed, are for educational and illustrative purposes only, and do not represent trading in actual accounts. Opinions expressed are that of the author.

The mention of specific asset class performance (i.e. +3.2%, -4.6%) is based on the noted source index (i.e. Newedge CTA Index, S&P 500 Index, etc.), and investors should take care to understand that any index performance is for the constituents of that index only, and does not represent the entire universe of possible investments within that asset class. And further, that there can be limitations and biases to indices such as survivorship and self reporting biases, and instant history.

The performance data for various Commodity Trading Advisor ("CTA") and Commodity Pools are compiled from various sources, including Barclay Hedge, RCM's own estimates of performance based on account managed by advisors on its books, and reports directly from the advisors. These performance figures should not be relied on independent of the individual advisor's disclosure document, which has important information regarding the method of calculation used, whether or not the performance includes proprietary results, and other important footnotes on the advisor's track record.

The mention of general asset class performance (i.e. managed futures did well, stocks were down, bonds were up) is based on RCM’s direct experience in those asset classes, estimates of performance of dozens of CTAs followed by RCM, and averaging of various indices designed to track said asset classes.

The mention of market based performance (i.e. Corn was up 5% today) reflects all available information as of the time and date of the publication.

The owner of this blog, RCM Alternatives, may receive various forms of compensation from certain investment managers highlighted and/or mentioned within the blog, including but not limited to retaining: a portion of trade commissions, a portion of the fees charged to investors by the investment managers, a portion of the fees for operating a fund for the investment managers via affiliate Attain Portfolio Advisors, or via direct payment for marketing services.

Managed Futures Disclaimer:

Past Performance is Not Necessarily Indicative of Future Results. The regulations of the CFTC require that prospective clients of a managed futures program (CTA) receive a disclosure document when they are solicited to enter into an agreement whereby the CTA will direct or guide the client’s commodity interest trading and that certain risk factors be highlighted. The disclosure document contains a complete description of the principal risk factors and each fee to be charged to your account by the CTA.

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Disclaimer

Forex trading, commodity trading, managed futures, and other alternative investments are complex and carry a risk of substantial losses. As such, they are not suitable for all investors.
The mention of market based performance (i.e. Corn was up 5% today) reflects all available information as of the time and date of the publication.